Lawmakers Discuss Downgrading Rating Agencies

Credit rating agencies, long revered for their judgment, may soon be getting a downgrade of their own if some lawmakers have their way.

Standard & Poor's, Moody's and Fitch have essentially enjoyed free reign to define creditworthiness. They determine what it means to be "investment grade" and what it means to peddle junk. These agencies even wield the authority to rate governments' financial strength.

Yet, these rating agencies failed to properly evaluate mortgage-backed securities, collateralized debt obligations and other exotic financial creations. Moreover they stamped toxic securities with triple-A ratings, thus playing a central role in the financial crisis.

In a CNN op-ed, Sens. Al Franken, D-Minn., and Roger Wicker, R-Miss., noted that the Justice Department filed a $5 billion lawsuit against Standard & Poor's. The duo said that the lawsuit alleges that the rating agency knowingly gave AAA ratings to unworthy products.

In 2008, Chris Raiter, formerly a managing director at Standard & Poor's went on television saying as much.

Explaining how standards were compromised, he told PBS' Now, "during this period profits were primary; analytics were secondary."

Such a "breach of trust" was common practice among the ratings agencies, the Senators claim in their article.

According to USA Today, not only were firms paying the ratings agencies, but also the firms helped to develop the very evaluation models by which they were assessed.

Franken and Wicker have pushed the idea that a Dodd-Frank provision they wrote, which suggests that a special board be created to make bond-rating assignments, should be part of the solution, according to USA Today.

The determination of which agency gets the jobs would be based on qualifications and track record. While firms would still foot the bill for their ratings, this process is intended to dissolve the incentive for rating agencies to issue high marks to win repeat customers.

"Our amendment was designed to bring accountability and transparency to the ratings process. In short, we want to replace pay-for-play with pay-for-performance, opening up the ratings process and establishing a competitive marketplace that rewards accuracy," they explained in their CNN op-ed.

Rep. Scott Garrett, R-N.J., is not a supporter of this idea. He argues that this assignment system would act as a "tacit" government endorsement of the ratings that are provided, MarketWatch reported.

Garrett noted his preference for another provision of Dodd Frank that would downgrade agencies' clout even more, according to USA Today.

Certain entities, such as mutual funds, are currently required to abide by agency definitions and thresholds that are set by these ratings agencies. A pension fund, for example, may be prohibited from purchasing any assets that are not deemed "investment grade." Therefore, they are bound by rating agencies' say-so.

According to USA Today, Garrett is in favor of stripping references to credit ratings from securities regulations altogether. Instead of relying on the judgment of agencies, the responsibility of adequate due diligence would be left up to investors.